Black Gold
A history of the oil industry and the lead-up to present day crisis.
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This intolerable dependence on foreign oil threatens our economic independence and the very security of our Nation - Jimmy Carter
Around 1840, a businessman in Pennsylvania named Samuel Kier had a peculiar problem. His salt mine was troubled by a foul-smelling oil that would come out during the mining process. The miners would generally dump the useless oil away into a canal but after it started catching fire, Kier started to experiment with the oil. Despite having no formal training in chemistry, Samuel Kier figured out a way to economically extract Kerosene from waste oil.
Even though Kerosene was known for some time, it wasn’t widely produced or used. Back then, the primary source of light was Whale Oil: in fact, whaling was the fifth largest industry in the world, but, whale oil was quite expensive compared to kerosene. Sensing the opportunity, Kier soon started an oil refinery in Pittsburgh for the crude oil from his salt wells. However, there was another problem soon: there wasn’t enough crude oil available to satisfy the demand.
A few years later in 1858, entrepreneur George Bissel and banker James Townsend sent a retired railroad conductor named Edwin Drake to Titusville after Bissel noticed locals there skimming crude oil from a creek.
Edwin Drake started his attempt at drilling through the oil creek and with some effort, he reached through layers of gravel, but around 16 feet, the walls of the hole began to collapse due to groundwater. He then pioneered the idea of using cast iron pipes to stabilize the hole, and also purchased a steam engine to drill further. However, he soon hit bedrock and the drilling slowed down to a snail’s pace.
The local residents of Titusville found Drake's search for oil ridiculous and named it “Drake’s Folly”. In fact, it was common for crowds of people to gather and jeer at his efforts. His colleagues had given up on the idea - however, Drake had invested nearly all of his savings into the drilling company and had further taken out a $500 loan to continue the operation.
On Saturday, August 27, 1859, when they had drilled nearly 70 feet, his drill bit hit a crevice. Exasperated, they packed up for the day and left. The next day, when his driller came and checked the hole, they saw a layer of crude oil floating above the water level. Edwin Drake had become the first man in America to strike oil by drilling for it. As fate would have it, the first shipment from Drake’s well was sent to Samuel Kier’s refinery.
The finding of oil led to the Pennsylvania oil rush. Thousands of entrepreneurs rushed to find their fortune by drilling for oil in Pennsylvania. In a span of 30 years, crude oil production in the United States went from 2000 Barrels to nearly 20 Million Barrels per year!
However, by the late 1860s, there was already an oversupply in the market and the price of oil fell from nearly 16 dollars a barrel in 1859 to less than 3 dollars a barrel in 1867. For the oil industry, this would only be the first of many boom and bust cycles.
Right now, we are going through a similar boom and bust cycle. Just a couple of years ago, crude oil price had gone negative and now, we are looking at a possible gas shortage. So this week, let’s take a look at how oil cycles happen, our dependence on imported oil, and what we can expect in the near future regarding oil prices.
Boom and Bust
An obvious thing about the oil industry is that extracting, refining, storing, and transporting oil is an extremely labor and capital-intensive process. However, what we often miss is how closely production and consumption have to be aligned for the industry to work smoothly.
A small fluctuation in supply or demand can make things go completely haywire. For example,
Demand drop - During the COVID crisis in 2020, demand for oil plummeted suddenly and oil producers had nowhere to store their supply. Because oil producers had to pay people to take away their supply, oil prices went negative.
Supply drop - During the Iranian revolution in 1979, oil production came to a standstill in the middle eastern country. Even though the overall reduction in global oil production was just 4%, the price of crude oil doubled resulting in the 1979 Oil Shock.
With a resource as critical as this, some oil-producing nations have realized that they can wield it as a tool in geopolitics to push their agenda. For example, during the 1973 Arab-Israeli war, Arab members of the Organization of Petroleum Exporting Countries imposed an embargo against the United States because of its decision to support Israel. The price of oil quadrupled in a year, shortages ensued and rationing became so common that some celebrities resorted to making underground bunkers to store gas. Congress also imposed a 55mph national speed limit to conserve gasoline, which would stay in place till 1995!
Looking back, there is an eerie amount of similarity between the 1970s and today with the burgeoning gas crisis, out-of-control inflation, and rising geopolitical tensions. But to fully understand the present situation, we need to know all the players in this 4D geopolitical chess.
OPEC
Straight up, the United States has nearly always been the world’s largest consumer of oil. Now, this wasn’t an issue when we were the biggest producers of oil. For example, in 1880, the United States was responsible for 85% of the world’s crude oil production and remained at 60-70% well into the twentieth century. However, toward the mid-1950s, some of the largest oil reserves in the world were discovered in the middle east diminishing the American oil dominance.
In 1960, five countries, Iran, Iraq, Kuwait, Saudi Arabia, and Venezuela came together to start the Organization of Petroleum Exporting Countries (OPEC). The organization has since then expanded by adding 8 more countries and now produces nearly 40% of the global oil supply while controlling more than 80% of the global oil reserves.
Much of the present-day crisis is a result of our dependence on oil imports, which is caused by two main reasons.
Supply - The United States uses nearly 20 Million barrels of oil per day, but we produce only 18.6 Million barrels per day. However, we produce the wrong type of oil and because of this, we have to import nearly 42% of our Oil supply. Out of this, nearly 11% comes from OPEC member nations.
Price - Another reason for our external oil dependence is price. Simply put, foreign oil is way cheaper than what is locally manufactured, For example, Saudi Arabia can produce oil for under $10 a barrel, while in the US, it costs around $23 per barrel.
The need for oil in the west has helped the economy of OPEC nations tremendously. . After oil was discovered there, the per capita GDP of Saudi Arabia went up nearly 23 times in the span of 1968 to 1983. Because of how closely tied their economy is to oil production, these countries will react sharply toward any effort to change the price of oil. They also try to destabilize the market and increase the market share.
That brings us to the present-day crisis. At a time of record-high global inflation, OPEC is doing the unthinkable by announcing that it will cut production by 2 Million barrels a day. The United States believes that this is a move towards supporting Russia by pressuring western nations with cost-of-living increases. How this will play out is anybody’s guess, but there have been efforts from our side to cushion the impact on average Americans.
American efforts
There are three key efforts by the US government to reduce prices.
After the oil embargo in 1973, the United States created the Strategic Petroleum Reserve, which can hold more than 700 Million Barrels to release strategically in times of hardship. The president has announced his intention of releasing 15 Million barrels of oil in December to ease prices.
Using the full creativity of a third grader who just learned about acronyms, Congress has named the NOPEC bill, which will allow the United States to sue OPEC for price manipulation - Although it remains to be seen how effective this will be given that it’s near impossible to enforce decisions against a foreign nation.
Finally, there are also efforts to bring down costs by encouraging production. The energy secretary announced that “the U.S. was working to identify at least 3 million barrels per day of new global oil supply”.
No matter how this plays out, there are going to be some ripple effects felt by the average consumer.
Aftershocks
There are two major ways in which this developing crisis can affect us. The first is a possible gas shortage like in the 1970s. The strategic petroleum reserve has fallen to the lowest level since 1984 and we’ve used 27% of the entire gasoline reserve. The second is how higher energy costs can lead to “Cost-Push” Inflation when manufacturing and transportation costs increase and get transferred to the consumer.
Personally, I believe that renewable energy is the future: it will reduce our reliance on foreign oil, however, it’s going to take time and the transition is going to be expensive. Higher oil prices also encourage consumers to move away from gasoline-powered products and diversify into solar energy and electric vehicles. Auto manufacturers are paying close attention to fuel efficiency: Ford plans to be fully electric by 2035 and California plans to ban the sale of gas-powered cars around the same time.
I hate to be the bearer of bad news, but in the short term, oil prices are likely to remain high resulting in higher prices for everything else. With a looming recession on the horizon, your best bet would be to cut back on savings and keep an emergency fund ready.
So stay safe, stay invested and I will see you guys next week - Graham Stephan.
A lot of effort and research went into making this article, so if you found it insightful, please help me out by clicking the like button and sharing this article.
Also, something as big as the oil industry cannot be fully covered in a single article, so let me know what I missed. I know that I have some older readers, so if you lived through the 1970s crisis, or you have a story your parents used to tell you, let me know in the comments below!
Another day another fine write up.
Alberta, your stable, democratic, ethical + environmentally responsible oil producing neighbour has the 3rd largest reserves in the world. Yet Biden cancels the Keystone pipeline his 1st day in office. That pipeline would have been able to supply the U.S with an additional 800,000 bbls per day.